Reliability of economic freedom indicators debatable

They should capture anomalies across countries for a true picture.

Ali Salman October 23, 2017

KUALA LUMPUR: As per Canada-based Fraser Institute’s Economic Freedom of the World report, Pakistan’s ranking in terms of economic freedom has improved 10 notches and it stood at 127th position out of total 159 countries.

However, Pakistan continues to be placed among the least economically free countries in the world.

Among the components of economic freedom, scores are given from 1 to 10 where a higher value indicates a higher level of economic freedom. In terms of size of the government, Pakistan’s score went down to 7.86 from 7.88 in last year’s report, in legal system and property rights, the score decreased to 3.30 from 3.37, in access to sound money, it increased to 6.38 from 6.21, in freedom to trade internationally, it declined to 5.77 from 5.82 and in regulation of credit, labour and business, it improved to 6.31 from 6.19.

I argue that these indicators are possibly valid, however, their reliability in the sense of application across economies is debatable. Let me explain. A key indicator of economic freedom is business freedom, which is typically measured, amongst other variables, by looking at the days spent in opening and closing a business entity.

In a pervasively corrupt society, this information is meaningless because it will only reflect the specific efficiency of respondent business firms in fighting with the particular bureaucratic rules. A lesser number of days spent may actually mean interplay of corruption whereas a greater number of days spent may mean insistence of an honest entrepreneur to strictly adopt the rules. This measure does not transmit consistently reliable and meaningful information about business freedom.

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Political connection

A conventional tool of measuring freedom would instantly downgrade that government for curbing freedom, and very rightly so. But then, a politically connected business tycoon, a combination which is a norm rather than an exception, would approach the government and get a temporary relief or exception for a specific time. It is even possible to get this temporary relief, legally, not just for a time but for specific parties also. How would a conventional measure of freedom classify this, or even come to know about this? Would it be a greater freedom or a lesser freedom?

Universal indicators of economic and political freedom are based on the principle of aggregation and averages to capture the levels of freedom of a nation-state. An underlying assumption is that of equality and standardisation across sub-national levels; where equality is not used in the sense of income, but in the sense of conditions and access to opportunities.

It is understandable to aggregate and thus average if the underlying commodities are of comparable sizes. However, averages tend to conceal underlying distribution which can lead to wrong analysis if that distribution is heavily skewed. This is true for most of the low-income countries, where noticeable differences exist between a metropolitan city and a town. This is again not about income inequality; rather it is about general conditions which impede equal access to opportunities and are reflected in, say, transport and communication networks or rule of law.

The latter point is also important as the level of enforcement of state varies both in degree and quality within a nation-state.

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State intervention

For Fraser Institute authors, the relationship is very linear. As the government intervention increases, which it measures by the size of the government with respect to GDP, economic freedom reduces. It is intuitively appealing as anything coming from a statist perspective would be questionable from libertarian view.

Certain types of government intervention particularly “non-coercive government activities” may not reduce economic freedom, though they can increase the size of the government.

Consider Nudging, whose founder William Thaler, was recently granted the Nobel Prize in Economics. Setting up such units signifies an increase in the size of the government, but it can be used to educate choices of citizens.

Similarly, in some countries, it is likely that the level of economic freedom is different for different groups of people. Specifically, it is possible that within a single country, women and men have different levels of economic freedom.

As to be argued shortly, such structural gaps can have important implications for the score and rank of a country on economic freedom.

It is interesting to see that the 2017 Economic Freedom of the World report acknowledges this and has introduced a weight to adjust for gender disparity. This opens the possibility of introduction of certain adjustment weights to accurately capture the anomalies across countries which will help in improving the reliability of measures.

The writer is the founder of PRIME Institute and is now based in Kuala Lumpur, where he is associated with the Institute of Democracy & Economic Affairs (IDEAS)

Published in The Express Tribune, October 23rd, 2017.

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